Mauritian Current Account Deficits To Narrow In 2019 On Higher European Demand

The Mauritian current account deficit will narrow from an estimated 6.7% of GDP in 2018 to 6.6% in 2019, marking the start of a narrowing trend that will last for the duration of our forecast period to 2027.

A free trade agreement with China that will boost Mauritius' re-exports and service exports is set to be ratified by 2019, while economic growth and a stronger exchange rate in the key European market will boost textiles and tourism sectors.

We stress that the narrowing in the deficit will be slowed by higher oil import costs, elevated capital goods imports as well as by ongoing headwinds to sugar exports.

Large inflows of direct and other investment will fund the current account deficit ensuring broad external account stability.

Revisions to Mauritius' double tax treaty with India will see portfolio investment flows remain in a deficit in the coming years. This will put some pressure on the financial account in the short term but will make the net international investment position less reliant on hot money flows.

Strengthening demand in Europe and a new free trade agreement (FTA) with China will help drive a narrowing of Mauritius' current account deficit. We believe that higher demand for Mauritian textiles and tourism exports will materialise in the years ahead due to steady economic growth in Europe coupled with a strengthening in the euro due to tighter monetary policy. Europe is the main market for the top goods and services exports from Mauritius - textiles and tourism.

Meanwhile, Mauritius signed a memorandum of understanding with China in September 2018, at the close of negotiations on free trade, and we believe that a free trade agreement (FTA) will be in place by early 2019. Though Mauritius runs a considerable goods trade deficit with China - amounting to USD836mn in 2017 - which will not be narrowed by the implementation of the FTA, we believe that the agreement will, on balance, contribute to a narrowing of the overall current account deficit by boosting services exports and re-exports.

Notably, we expect that existing FTAs that Mauritius holds with three African blocs combined with the incipient FTA with China will make it an ideal goods re-export hub. As the Port Louis docks and storage facilities are expanded, Mauritius will capable of significantly boosting re-exports and service exports via transport and storage services - an area of the economy that accounts for 12.7% of total services exports in 2017.

We stress however that the pace of deficit consolidation will be slow, as several key factors will lead to persistent current account deficits over our forecast period. These factors include:

Rising Brent crude prices - set to increase from an average of UD75.0/bbl in 2018 to USD82.0/bbl in 2019. This will increase the cost of Mauritius' largest goods import.

Ongoing construction projects, notably the expansion of the Port Louis docks and the Port-Louis Curepipe railway, will sustain high demand for capital goods imports. These imports accounted for 15.5% of total good imports in 2017.

The lifting of EU sugar quotas will continue to erode Mauritian sugar exports in their largest market. Though China agreed to buy 50,000 metric tons of Mauritian sugar as an incentive to signing an FTA in 2018, this order represents less than Q218's total exports and does not appear to be a recurring arrangement, limiting the degree of support for the commodity.

Financial account inflows will be sufficient to cover the current account deficits, ensuring external account stability. Direct and other investment posted significant net inflows in Q218, which we expect will continue in the coming years due to extensive European, Chinese and Indian investment into various development projects on the island. Such investment will ensure overall financial account stability over the coming years.

Foreign Depositors Withdraw Assets From Mauritius, Weighing On Financial Account In The Short Term

Mauritius - Foreign Liabilities, MURbn

Source: Bank of Mauritius, Fitch Solutions

The decline in portfolio investment inflows is a key trend to note, swinging from a net inflow of MUR14.7bn to MUR7.5bn in outflows between Q217 and Q218. We believe that this flow reversal reflects foreign investors withdrawing portfolio investment due to full implementation of revisions to Mauritius' double tax treaty with India. After having previously had very low rates of capital gains tax (CGT) on investments in India, treaty revisions mean that Mauritius is raising its CGT to half India rates between April 2017 and April 2019, before making CGT rates the same as India's thereafter. This will remove one of the main advantages of basing capital in Mauritius, which has hitherto been one of India's main sources of foreign investment in part due to the tax treaty. The move has already led to a fall in foreign liabilities to their lowest level since 2010 - declining by 35.2% between April 2018 and July 2018, alone. We believe that this trend will accelerate from April 2019, when CGT rates are fully harmonised. Though the decline in foreign liabilities will weigh on financial account inflows to some extent, it will see the financial account be less reliant on hot money flows than previously and instead become more stable in the long run.